A Breath Warning From SPXA50R

There are a number of good ways at looking at breadth. One is discussed below. It is the percentage of the S&P 500 trading above its 50 day moving average (dma). On Stock Charts, the symbol for this is SPXA50R.

The concept is simple: rising prices on SPX should be accompanied by a greater number of companies trading above their 50-dma. In the current uptrend, more than 90% of the SPX were trading above their 50-dma in late January. There was no divergence between breath and price.

Since then, SPX has made new highs while the number of companies above their 50-dma has fallen to 74%. This is a negative divergence.

Sometimes, price and breath peak together; at other times, breadth leads and gives a warning about the deteriorating underlying quality of the advance.

In the chart below, we have plotted a smoothed SPXA50R (red line) against SPX (blue line) since 2007. The divergence between breath and price can last 1 month (in rare cases, 2 months) but the result is the same, with a decline in SPX of 5-10% to follow (some were more).

In the present case, SPXA50R (as calculated; see notes below) has been declining for 3 weeks. The time for a corresponding move in SPX is within the next few weeks, but typically earlier.

Sellers Are In Control

This is a follow on to last week's post on the first major distribution day (MDD) since November (read it here). Recall that a MDD occurs when down volume is more than 90% of total volume on the NYSE.

At the time, we postulated that (1) an MDD the day after a new high in $SPX portends further downside, and (2) that a cluster of MDDs would indicate sellers are in control and lower prices will prevail. Sure enough, yesterday a second MDD hit the market that knocked out all the gains in the indices from over the past month.

Today, all 4 US indices and 6 of 6 cyclical SPX sectors are below their 20-dma. Watch the slope of those averages; the rest of the world has led the US markets, and their averages are now down sloping (see first chart, below). The US appears to be in the process of resynchronizing with those markets (second chart).

For at least the short term, sellers are in control of the market, and will remain so until one or both of the following transpire:

1. US indices and a majority of the 6 cyclical sectors on the SPX regain their upward sloping 13-ema (or 20-dma), showing that the trend remains higher and is being led by economically sensitive stocks.
2. Breadth swings forcefully in favor of bulls. In the third chart below, you can see that in the past, following a cluster of MDDs (red bars, bottom panel), the rebound only took hold when up volume exceeded 90% - a major accumulation day (MAD; middle panel with the green bars). Strong positive breath pushes a large number of stocks higher. With some follow through, $NYMO will also turn positive and $NYSI will regain its positive slope. An intervening distribution day obviously puts the ball back with the sellers (see May-June 2010).

Again, for the time being, sellers remain in control. Charts below.

What Today's Major Distribution Day Means for $SPX

Down volume on the NYSE was over 90% of total volume today, an event known as a major distribution day (MDD). This is a measure of breadth; recall in the weekly market summary that breadth is second after trend in importance, so a MDD is of significance.

Today's MDD was the first since the mid-November low in $SPX. A few points:

1. Yesterday, SPX formed a new high. Today, all those gains were given back on trading dominated by sellers. This, in the past, has been a bad combination. See the first chart below (red arrows). Selling momentum typically carries over into the following period. 
2. Today's set up is eerily similar to April 2010 and February 2011. See the first two red arrows on the first chart: a long, grinding uptrend capped by a MDD. April 2010 double topped within a week; February 2011 began a multi-month topping process. Either one of these is a possibility.
3. Not all MDD's are the same. After a downtrend, an MDD can mark the point of capitulation. See the second chart below (green arrows). This was the case at both the June and November lows in 2012. 
4. Some MDDs are rogue and some come in clusters. See the red rectangles at the bottom of chart three. It should not be a big surprise that a cluster of MDDs will lead to a substantial decline in $SPX. We have to be on watch now for another day like today.
5. Finally, today is day one of major selling in 2013, and its coming after a 7 week uptrend. Long uptrends like that, in the past, have not ended without at least a second attempt at the recent highs. Read further here and here. 

Breadth Divergence Watch

One of the two main drivers of the Weekly Market Summary is breadth. It has been unmistakably strong since the November low. The chart below looks at $SPX in the top panel versus NYMO (middle) and NYSI (bottom). 

Generally, weak breadth (NYMO below zero) leads to weak prices. See September-November 2012 as an example. This week, NYMO returned below zero. If the stay is brief, then there is no problem. If this persists, NYSI (bottom) will start to fall and price usually follows. 

Note the long negative divergence between NYSI and price between February and March 2012 (yellow arrows). Eventually, it resolved to the downside with a 10% correction in $SPX. 

Summation Index Climbs Higher

One of the main reasons to remain optimistic on the market is that breadth continues to expand.  Today, $NYSI (the McClellan Summation Index) closed above 700. As the chart below shows, when summation becomes oversold (below -500) and then climbs back above 500, market indices usually continue to climb higher. That is the current situation.